Organizational Forms

1. Organizational Forms Sole Proprietorship Partnership Corporation Subchapter S Corporation Limited Liability Partnership Limited Liability Companies Limited Partnership Non-Profit Entity

2. Important Considerations Control: How many cooks are in the kitchen? Flexibility: A sports car or a battleship? Liability: Who gets left holding the bag? Longevity: Nobody lives forever… Access to Capital: Sweat equity or OPM? Taxation: Once, twice, or not at all? Bureaucratic BS: How red is the tape? Cost: Pay a little or pay a lot?

3. Sole Proprietorship • Simplest to start and maintain • Most common structure • Least costly • Highest personal risk • Income is taxed as personal income

4. Sole Proprietorship Taxation • Taxable income “passes through” the business • Personal income and business income are combined and taxed as one • May put you in a higher tax bracket • Losses can be used to offset personal income

5. Sole Proprietorship Taxes Form 1040 Schedule C or Schedule C-EZ: Profit and Loss From Business -- Sole Proprietorship Form 1040 ES: Acceleration Estimate Tax for Individuals -- Must estimate expected income tax for the coming year Quarterly vouchers and payments

6. Sole Proprietorship Legal Stuff No registration required if business is in your own name If you change the name or use anything other than your own name, must file Certificate of Conducting Business Under An Assumed Name with Secretary of State. Right of Survivorship Document – Says what will happen in case of your death To end business – Liquidate assets, pay off debts, and walk away.

7. Sole Proprietorship Summary Control: You’ve got it all Flexibility: It’s your decision (alone) Liability: You’ve got it all Longevity: Nobody lives forever… Capital: Your money, bank debt, and trade credit Taxation: Once, but not many breaks Bureaucratic BS: Almost none Cost: Very little

8. Partnership • Use if more than one person’s capital • Can be oral or written, but non-idiots put it in writing • Terminates with the death of any partner in most states – Can use “Key Man” insurance to provide for the continuation of the partnership • Liability is joint and several unless there are limited partners

9. Partnership Taxes Form 1040 with proportional share of partnership income Form 1065: US Partnership Return of Income Schedule K-1: Partner’s Share of Income Credits, Deductions, etc. Each partner calculates and files an estimated tax Quarterly vouchers and payments

10. Types of Partnerships General Partnership • Partners are equally liable (joint and several) • Share workload and decision making • Operates on a calendar year • Generally cash-based accounting

11. Types of Partnerships Limited Partnership • One or more partners are merely investors and do not participate in running the business or making decisions. • Limited partners have share of ownership but liability is limited to the amount of the investment • Must have at least one general partner

12. Partnership Legal Stuff The partnership name and information about the partners must be filed Written partnership agreement is optional Estate planning (what happens when a partner dies) is essential, but complicated All personal assets of all general partners are at risk Partnership terminates with the death of any partner unless partnership agreement specifies otherwise

13. Partnership Summary Control: Shared between the partners Flexibility: Now it’s a committee... Liability: Joint and several Longevity: Nobody lives forever… Capital: Partners’ money and some debt Taxation: Once, but not many breaks Bureaucratic BS: Some - Partnership agreements, more stringent records Cost: Very little

14. Corporations • Most difficult and costly to set up • Provides the most benefits to the owners • Separate legal entity – provides limited liability for all owners • Best access to capital markets • Easiest in which to transfer ownership • Income is taxed twice – once at the corporate level and once at the personal level – but otherwise gets very favorable tax treatment • Most closely scrutinized by the US Government and (if publicly traded) by the SEC

15. The Corporate Form of Organization • Ownership The shareholders (also known as stockholders or equity holders) are the owners of the corporation. • Control Ultimate control rests with the shareholders, but the managers control the day to day operations. • Risk Bearing While all parties associated with the corporation bear risk, shareholders bear all residual risk.

16. Flow of Control in a Corporation Shareholders Board of Directors Managers

17. Corporation Taxes VERY complicated and constantly changing Owners file a Form 1040 with personal and dividend income included The Corporation files a Form 1120 – US Corporation Income Tax Return – if gross receipts, total income, or total assets are over $500,000 Form 1120A (Short form) if any of the three are under $500,000 (… some other rules)

18. Corporation Summary Control: LOTS of cooks Flexibility: Now it’s a BIG committee... Liability: Limited personal liability Longevity: Nobody lives forever… So what? Capital: Best access of all forms Taxation: Twice, but many deductions and breaks Bureaucratic BS: Lots and lots and lots and… Cost: Can be substantial

19. Rights of Ownership in Corporations Dividend Rights Voting Rights majority voting one vote per share per director cannot combine votes cumulative voting directors are voted on jointly can cast all votes for a single candidate

20. Rights of Ownership (contd.) Liquidation Rights Owners have the right to a proportional share of the firm’s residual value in the event of liquidation, after other senior claims are paid. Preemptive Rights Owners have the right to subscribe proportionally to any new shares issued by the firm.

21. Forming a Corporation What do you need? • $50 (In Mississippi) • Company name (unique) • Directors • Business address • [Federal Tax ID] • [Corporate Charter]

22. Interesting Statistics • Number of US businesses • Number of US businesses by revenue size • Number of US corporations by Industry • Number of US sole proprietorships by industry • Number of US partnerships by industry • Number of businesses by state • Most popular small businesses

23. Businesses by State BusinessesByState.xls

24. Need Help? Small Business Development Center Sec. Of State - www.sos.state.ms.us MyCorporation.com Incorporate USA Company Corporation CorpAmerica BizFilings.com Quick-Inc.com

25. Subchapter S Corporation Owners retain limited liability Taxed as a partnership - eliminates double taxation and makes it easier for owners to be compensated All profits are taxed and distributed annually

26. Subchapter S Corporation A corporation can elect S-Corp status within 75 days of formation if: • It is a domestic corporation (i.e., it operates in the state in which it is franchised • There is only one class of stock • It has 75 or fewer stockholders • All stockholders are US citizens or resident aliens • There are no subsidiaries

27. Limited Liability Company (LLC) Owned by “members” who may run the company or appoint managers to do it Members and managers have limited liability Taxed like a Subchapter S Corporation without having to conform to the S Corp restrictions Limited liability can make it harder to raise capital - may require personal guarantees

28. Limited Liability Partnership (LLP) Also called a Professional Corporation Used primarily by those who render professional services - lawyers, doctors, architects, social workers, etc. Some tax advantages - possible tax shelter Not much liability limitation

29. Information Sources The Quick-Inc Guide to Business Entities LLCs on MyCorporation.com LLCs on BizFilings.com BizFilings.com Comparison of: C Corp to S Corp, S Corp to LLC, C Corp to LLC

30. Piercing the Corporate Veil Creditors may attempt to recover money from shareholders if: • The business was initially underfunded or “thinly capitalized” • The owners failed to treat the business as a separate entity themselves: Fail to use Inc. or Corp or LLC in dealings Co-mingle assets or funds Fail to keep good records and hold meetings

31. The Goal of the Firm “Maximize Shareholder Wealth” • Better defined than profits • Is an objective external measure • Considers timing of cash flows • Considers all internal and external factors • Considers risk differences between alternative courses of action

32. Three Types of Decisions Investment Decisions How should capital be invested? Financing Decision How should the assets be financed? Managerial Decisions How large should the firm be? How fast should it grow? Should the firm grant credit to a customer? How should the managers be compensated?

33. The Investment Vehicle Model of the Firm • Investors provide financing to the firm in exchange for financial securities. • Firm invests these funds in assets. • Income generated by the firm is distributed to the investors. • Managers act in the best interest of the shareholders, and take actions to maximize shareholder wealth.

34. The Investment Vehicle Model of the Firm The Firm Financial Markets Exchange of Money and Real Assets Investors The World Investment Decisions Financing Decisions Exchange of Money and Financial Assets Financial Intermediaries Corporate Financial Management Financial Markets and Intermediaries Investments

35. The Accounting Model of the Firm • Balance sheetview of the firm. • Investment decisions are represented on the asset (i.e. left hand) side of the balance sheet. • Financing decisions are represented on the liabilities and equity (i.e. right hand) side of the balance sheet.

36. Long Term Liabilities Long Term Debt Current Debt Total Fixed Assets Tangible Fixed Assets Intangible Fixed Assets Shareholder’s Equity Common Stock Retained Earnings The Accounting Model of the Firm The Investment Decision The Financing Decision Current Assets Cash Marketable Securities Accounts Receivable Inventory Current Liabilities Accounts Payable Current Debt Net Working Capital

37. Set of Contracts Model of the Firm • The firm has contracts with a large number of stakeholders. • These contracts may be explicit or implicit. • Contracts may also be contingent on particular future outcomes. • The model recognizes that conflicts of interest may exist between the various stakeholders.

38. Set of Contracts Model of the Firm Banks Bondholders Customers Employees Governments Environment The Firm Common Stockholders Preferred Stockholders Communities Society Creditors Suppliers Managers

39. The Agency Model of the Firm • Managers have day-to-day operational control of the modern corporation and are supposed to act as agents for the shareholders. • Managers have goals that differ from those of the shareholders. • Shareholders must incur costs to make sure that their "agents" act in their best interests. • Monitoring costs • Incentive costs

40. Notes on sources for this presentation This presentation includes material provided in the Chapter 2 slide presentation for Corporate Finance by Emery and Finnerty (Prentice Hall) and Chapter 3 in Ready or Not, Get Set Go by Sheila Taylor-Downer (Professional Prodigy, Inc.)